the insolvency and bankruptcy code: economic rationale ... · the insolvency and bankruptcy code:...

The Insolvency and Bankruptcy Code: economicrationale, the law and some recent developments

Bhargavi ZaveriFinance Research Group,

Indira Gandhi Institute of Development Research

16th September, 2019

Structure of the talk

I Why do/did we need a bankruptcy framework?I Goals of the IBCI Design principlesI Contextualising some recent developments to design principles

Some history and trivia ...

Pre-IBC insolvency frameworks

Recovery rates

Year DRTs SARFAESI2012-13 14.19 27.172013-14 9.58 26.552014-15 6.95 16.332015-16 9.24 16.48

Source: RBI Statistical TablesRelating to banking

Outcomes under CDR

Cases referred since inception 656 474,351Total cases approved for referral to CDR 531(81%) 403,353Cases exited successfully 111 (21%) 84,677 (21%)Cases withdrawn/ exited on failure 298 1,84,581 (46%)Live cases 121 1,32,948

Source: CDR Cell (year unknown)

I SDR: 15 cases (till December 2015) with debt of Rs.0.8 trillion. 11 cases arefrom CDR and 2 from CDR group companies.

I BIFR: 6,991 references made. 760 schemes approved. 1,303 cases referred forwinding up. 1,297 cases pending.

Takeaways

1. Fragmented legal framework. Largely focused onre-organisation.

2. Some creditors were more equal than others. Not all creditorshad a seat at the table or the power to trigger.

3. Legal uncertainty.4. Opaqueness and endless timelines.

Pre-IBC outcomes

India US UK Singapore CanadaResolving insolvency rank 136 5 13 27 16Time (years) 4.3 1.5 1 0.8 0.8Recovery rate 25.7 80.4 88.6 89.7 87.3

Getting credit rank 42 2 19 19 7To non-financial sector 1 59.5 149.8 156.3 144.8 203.9O/w bank credit 2 93.5 33.4 57 85.4 51.1

Source: World Bank: Doing Business, 2015;BIS: long series on total credit to non-financial sectors, 2015

1% of GDP2% of total

Pre-IBC outcomes

India US UK Singapore CanadaResolving insolvency rank 136 5 13 27 16Time (years) 4.3 1.5 1 0.8 0.8Recovery rate 25.7 80.4 88.6 89.7 87.3Getting credit rank 42 2 19 19 7To non-financial sector 1 59.5 149.8 156.3 144.8 203.9O/w bank credit 2 93.5 33.4 57 85.4 51.1

Source: World Bank: Doing Business, 2015;BIS: long series on total credit to non-financial sectors, 2015

1% of GDP2% of total

No way to fix the system through incremental changes.

Why not just have a debtors prison?

I Countries which encourage risk taking fare betterI Access to equity capital, limited liability, clean bankruptcy

process will encourage more firms to innovate and try riskybusiness ventures.

I Britain invented limited liability, and the bargain was:1. The firm accepts disclosure2. Both lender and borrower work within the bankruptcy process3. In return the firm gets limited liability.

I Limited liability means the shareholder gets to drive around inhis personal Mercedes Benz while the firm is in default.

Goals of IBC

1. A unified legal regime governing bankruptcy in IndiaI entity-agnosticI respecting the nuances of individual insolvency

2. Equalising the right to trigger3. Collective action process4. Creditor-driven decision making5. Role of judiciary restricted to oversight of due process6. Insitutions to support the bankruptcy process of firms and

individuals


2. Equalising the right to trigger

3. Collective action process4. Creditor-driven decision making5. Role of judiciary restricted to oversight of due process6. Insitutions to support the bankruptcy process of firms and

individuals


2. Equalising the right to trigger3. Collective action process

4. Creditor-driven decision making5. Role of judiciary restricted to oversight of due process6. Insitutions to support the bankruptcy process of firms and

individuals


2. Equalising the right to trigger3. Collective action process4. Creditor-driven decision making

5. Role of judiciary restricted to oversight of due process6. Insitutions to support the bankruptcy process of firms and

individuals


2. Equalising the right to trigger3. Collective action process4. Creditor-driven decision making5. Role of judiciary restricted to oversight of due process

6. Insitutions to support the bankruptcy process of firms andindividuals


2. Equalising the right to trigger3. Collective action process4. Creditor-driven decision making5. Role of judiciary restricted to oversight of due process6. Insitutions to support the bankruptcy process of firms and

individuals

Design principles

What is the contract between debt and equity?

I Equity owners have controlI If they pay on their debt on time, all is wellI When they default, equity gets expropriated and control

transfers to the creditors.I The creditors will decide whether to sell it as a going concern

or to carve it up to pieces and put these up to auction.

Unified legal regime governing insolvency

Entity-agnosticI all persons incorporated with limited liability, except financial

service providersI statutory corporationsI co-operative societies

I all individuals and unincorporated partnerships.Trusts?




I all individuals and unincorporated partnerships.

Trusts?




I all individuals and unincorporated partnerships.Trusts?

Equalising the right to trigger

I Debtors can trigger on committing defaultI Fresh start process for indigent individual debtors.

I Creditors can trigger if a corporate debtor has committeddefault of more than Rs. 100,000

I Creditors can trigger if an individual debtor who has notapplied for fresh start commits a defaultI in case of a partnership firm, all or majority of the firm must

apply.I Trigger rights in case of a cross-default.





apply.

I Trigger rights in case of a cross-default.





apply.I Trigger rights in case of a cross-default.

Collective action process

A debtor may be insolvent because of:1. Financial failure: a persistent mismatch between payments by the enterprise and

receivables into the enterprise, even though the business model is generatingrevenues, or

2. Business failure: a breakdown in the business model of the enterprise, and it isunable to generate sufficient revenues to meet payments.

I Collective action process and calm period to allow creditors toidentify which one is it.

I Settlement once collective action is triggered.I Core idea of transparency.

Time-bound decision making

I The 180 day period, coupled with the threat of liquidation, inthe collective action process solves the incentive problem.

I A one-time extension of 90 days, for reasons to be recorded inwriting.

I Automatic liquidation disincentivizes protracted negotiation.Timeline now extended to 330 days.3

3IBC Amendment Act, 2019

Collective action process: seat on the table

I Costs of including operational creditors into the creditorscommittee

I Anti-liquidation biasI Incentives of financial creditors to be fairI 66 completed resolution processes (as in December 2018):4

I Avg. recovery rates for operational creditors: 47.45%I Avg. recovery rates for financial creditors: 45.84%

I Counterfactual: expensive mechanisms for class-voting.

How do we think about home buyers?

4IBBI data

Collective action process: seat on the table

I Costs of including operational creditors into the creditorscommittee

I Anti-liquidation biasI Incentives of financial creditors to be fairI 66 completed resolution processes (as in December 2018):4

I Avg. recovery rates for operational creditors: 47.45%I Avg. recovery rates for financial creditors: 45.84%

I Counterfactual: expensive mechanisms for class-voting.How do we think about home buyers?

4IBBI data

Creditor-driven decision making

1. Management displaced on commencement of the CIRP, andaffairs of the firm handed over to an insolvency resolutionprofessional.

2. Key decisions during corporate insolvency resolution processto be taken by a vote of creditors’ committee.

3. Creditors’ committee decides what resolution plan getsapproved.

I Does the IBC have a built-in re-organisation bias?5

5Supreme Court judgements in Arcelor Mittal and Swiss Ribbons

Role of judiciary (the legislature and the regulator!)

Role of judiciary, legislature and regulator excluded fromcommercial decision-making.

I Creditors are best placed to take commercial calls that affect their own rights.I Statutory bodies and judges are ill-equipped to make these calls.

I Decision of the NCLAT in Standard Chartered v. Satish Kumar Gupta (2019)I Section 30(2)(b) of the IBC.6

6Added by the Insolvency and Bankruptcy Code (Amendment) Act, 2019

Institutions

I Insolvency professionals and insolvency professionalassociations

I Information utilitiesI Judiciary

Contextualising key developments to the economic rationale anddesign principles.

Legacy issues

1. Section 29A and its implicationsLow recovery rates

Moral hazard risksComplexityAre we achieving the intent?7

2. Home buyers as financial creditors.Will their vote matter?

Moral hazard risksLaw of unintended conse-quencesWill RERA or consumer protec-tion laws solve this better?Can we assure a floor recovery?

7Ex: Section 12A withdrawal and settlement

Judicial and executive roles in a bankruptcy framework

1. Does the IBC have a built-in re-organisation bias?I Swiss Ribbons Pvt. Ltd. and Anr. v. UOI and Ors. (2018)I “Liquidation as a going concern”

2. Group insolvencyI Decision of NCLT in Videocon Ltd. (2009): implications for

limited liability.I Procedural co-ordination v. substantive consolidation

Judicial and executive roles in a bankruptcy framework

Section 30(2)(b) of the IBC: priority of payments in a resolutionapplication.8Operational creditors must receive amount set out by the IBBI,which should not be lower than:

1. liquidation value; or2. share of the resolution proceeds if they were to be distributed

as per the liquidation waterfall.

8IBC (Amendment) Act, 2019

Thank youwww.ifrogs.org

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